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Is The Stock Market A Pyramid Scheme?

A pyramid scheme typically favors those who join early, as against those who come in at the later stages. The same is true about the stock market. But does that make the stock market a pyramid scheme?

Keep in mind that a pyramid scheme is a centralized venture in which a criminal sets out to take people’s money, whereas the stock market is a bourse, or a collection of investments.

Nevertheless, some of these investments can be terrible; they can be cleverly designed to take money from investors, leaving them holding bag.

Is The Stock Market A Pyramid Scheme?

What is The Stock Market?

The stock market is a design to allow companies inject fresh capital into their business, by selling shares to ordinary people. In return, ordinary people can get rewarded by receiving dividends, which reflect a portion of the profits of the companies. Most times people are concerned with the prices of the stocks, that is when it increases after buying. Keep this in mind for the rest of the article.

Be aware that sometimes, the stock market is also an escape route for the owners of a company; they can decide to take back the money they have invested into a company by selling shares of that company to the public.

They will continue to receive dividends from the profits, but then that is only an additional perk. To those kinds of people, after selling shares, the company is no longer their headache; if it burns, it burns.

However, the stock market has some measures to prevent burning.

The Stock Market- The Good

Voting Rights

The stock market is designed such that when a person buys stocks in a company, he also gets a right to have a say in the decision making processes of the company. Annual General Meetings are held every year, and important matters pertaining to the success or continued success of the company are discussed.

Each person gets a vote, and the larger the amount of shares a person has, the more the voting power the person has. For a small person, this may not look like a lot, but there is strength in numbers; the room is filled with people who have invested into the company; some of them have invested heavily.

They will all want what is good for their investments; what is good for the company.

Company History

You have the opportunity to research the history of any company before putting your hard earned money. One thing that remains a classic is the dividend history; that is the company’s track record of paying dividends over the years.

Other important things to look at include the industry where the company operates. Is it profitable? Is it sustainable?

For example, would you invest your money in a coal mining company? Or would you invest in an electricity company? How about an electric car company?

Of the three companies cited above, one is a dying industry, the other is a thriving industry, and the other is a new industry. That can serve as a basic guide- a way to look at the stock market. Furthermore, some people prefer to invest in new industries.

New Industries

New industries are those that are just coming up, or just starting out. The usually come as Penny Stocks, priced very low, and easily accessible to investors with small amounts of capital. Two things can happen, the business could fail, in which case the investors lose only small amounts of their savings; or the business becomes successful, and the investors get rich.

New industries usually enter the stock market with a lot of pomp. They do something called an Initial Public Offer, or an IPO.

IPOs can be a great way to invest in the stock market, and at the same time they can also be exactly why some say the stock market is a Ponzi Scheme.

But Why Does The Stock Market Look Like A Ponzi Scheme?

For one thing, IPOs are often sold to the public at inflated values. In order words, the owners of the companies quote the values of their companies at higher prices than what they are actually worth, and then soon after innocent people have bought the shares, the prices go down, resulting in instant losses for investors.

Those instant loses are instant gains for the people who own the companies; they have taken money and value from the people.

Secondly, the market is designed in a way that benefits early comers. In fact, the only reason why a stock’s price rises in the first place is that there are people buying at higher prices. Therefore, the stock market is designed to pay old investors by taking money from new investors. Classic Ponzi scheme.

Furthermore, the fundamentals of the stock market have been eroded. For example, people should buy stocks with the hope of being rewarded through dividends.  That means dividend paying stocks should get all the demand, and those who do not pay should be cheap.

Sadly though, with the advent of so called “Growth Stocks” people just buy stocks with the intention of selling for higher prices. Growth Stocks are those that do not pay dividends, but (presumably) reinvest their profits in the businesses to as to improve their standings in their various industries.

This is a deviation from the founding principles of the stock market; now it is just a farce sustained by the Greater Fool Theory. This is why bubbles form and burst every time. Perhaps, the whole thing is one big bubble that will one day pop with a loud bang.

Further Reading:

Closing

To some extent at least, the stock market is a Ponzi scheme; one legalized by the government. Nevertheless, it can be a place to invest for oneself and for one’s children. This can be done by investing in solid companies, with solid fundamentals, and solid dividend histories.

Such companies are not Ponzis; they are true investments that offer good chances to create wealth for the future.

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